Individual Retirement Accounts (IRAs) are legally mandated retirement savings accounts. Traditional IRAs allow you to grow your money tax-free, with minimal distributions starting at age 70 1/2 (depending on your life expectancy). Roth IRAs allow you to grow your money tax-free while also requiring no minimum distributions.
When you die and leave your IRA to your spouse, he or she can choose to roll it over into their own name or take it as an inherited IRA. Transfers of assets to a spouse upon death if you are legally married in Pennsylvania result in a 0% Pennsylvania Inheritance Tax. There was formerly a widows tax in Pennsylvania, but it was repealed in 1994. Obviously, the law may change again, but reintroducing the widows tax would undoubtedly be unpopular across the political spectrum. In the end, if your estate is correctly put up, there should be no probate and no inheritance tax for spouses. For Pennsylvania Inheritance Tax reasons, domestic partners and non-married couples are taxed at a rate of 15%.
If a child or non-spousal beneficiary inherits your IRA, they can choose to accept a lump sum distribution (which isn’t a good idea because they’ll have to pay ALL income taxes up front!) or a regular distribution (which isn’t a good idea because they’ll have to pay ALL income taxes up front!). Alternatively, you can keep it as a Beneficiary IRA. A “stretch-out” IRA is another name for this type of IRA. Although IRAs are not subject to probate, they are liable to Pennsylvania Inheritance Tax (4.5 percent for children and grandchildren, 12 percent for siblings, and 15% for all other non-spousal beneficiaries). Even if your beneficiary does not take a lump-sum distribution when you die, they will still have to pay inheritance tax on the whole IRA value. If your IRA is worth $100,000, it will pay you $4,500 when you die.
The Pennsylvania Inheritance Tax Code applies to all counties in Pennsylvania, including Philadelphia, Bucks County, and Montgomery County.
Is an IRA subject to Pennsylvania inheritance tax?
IRAs, both standard and Roth, may be subject to Pennsylvania inheritance tax, despite the fact that they are normally non-probate assets (not governed by the decedent’s Will) (in addition to income tax for beneficiaries of traditional IRAs when drawn upon). The IRA will be subject to PA inheritance tax if the decedent was above the age of 59-1/2 at the time of death. The IRA will not be liable to inheritance tax if the decedent was under the age of 59-1/2 at the time of death. The appropriate inheritance tax rate is currently 0% if spouses are named beneficiaries of IRAs, and 4.5 percent where children and grandchildren are named beneficiaries. It is critical for persons with IRAs to review their beneficiary designations, both primary and supplementary, to verify that they are complete and up to date.
When a spouse is the designated beneficiary of a traditional IRA, that spouse typically has the option to roll over the inherited IRA into the surviving spouse’s own IRA, deferring payment of income tax until that spouse reaches age 70 1/2, after which the inherited IRA proceeds are withdrawn over that spouse’s lifetime.
When children are beneficiaries, they typically have the option to I roll the inherited IRA into a “stretch” IRA over the child’s lifetime (or the lifetime of the oldest child if there are multiple child beneficiaries) and begin taking required minimum distributions by December 31st of the year following the decedent’s death; ii) cash out the IRA in full or ii) cash out the IRA over five (5) years (by December 31st of the fifth year following
During the year in which the funds are withdrawn, each withdrawal will be included in the beneficiary’s taxable income.
Please be aware that Congress is considering legislation that would limit the lifespan of a stretch IRA for non-spouse beneficiaries to ten (10) years following the death of the original IRA owner, rather than the non-spouse beneficiary’s lifetime.
For many of us, IRAs represent a big part of our retirement portfolios, and precise and comprehensive beneficiary designation is critical. It’s critical for beneficiaries inheriting IRAs to understand their options once the IRA owner passes away. Gross McGinley’s Estates Practice Group can answer any concerns you have regarding IRAs and advise you on IRA holdings and distributions so that your intentions and wishes are carried out.
Spouses get the most leeway
If a survivor inherits an IRA from their deceased spouse, they have numerous options for how to spend it:
- Roll the IRA over into another account, such as another IRA or a qualified employment plan, such as a 403(b) plan, as if it were your own.
Depending on your age, you may be compelled to take required minimum distributions if you are the lone beneficiary and regard the IRA as your own. However, in certain instances, you may be able to avoid making a withdrawal.
“When it comes to IRAs inherited from a spouse, Frank St. Onge, an enrolled agent with Total Financial Planning, LLC in the Detroit region, says, “If you were not interested in pulling money out at this time, you could let that money continue to grow in the IRA until you reach age 72.”
Furthermore, couples “are permitted to roll their IRA into a personal account. That brings everything back to normal. They can now choose their own successor beneficiary and manage the IRA as if it were their own, according to Carol Tully, CPA, principal at Wolf & Co. in Boston.
The IRS has more information on your options, including what you can do with a Roth IRA, which has different regulations than ordinary IRAs.
Choose when to take your money
If you’ve inherited an IRA, you’ll need to move quickly to prevent violating IRS regulations. You can roll over the inherited IRA into your own account if you’re the surviving spouse, but no one else will be able to do so. You’ll also have several more alternatives for receiving the funds.
If you’re the spouse of the original IRA owner, chronically ill or disabled, a minor kid, or not fewer than 10 years younger than the original owner, you have more alternatives as an inheritor. If you don’t fit into one of these groups, you must follow a different set of guidelines.
- The “stretch option,” which keeps the funds in the IRA for as long as feasible, allows you to take distributions over your life expectancy.
- You must liquidate the account within five years of the original owner’s death if you do not do so.
The stretch IRA is a tax-advantaged version of the pot of gold at the end of the rainbow. The opportunity to shield cash from taxation while they potentially increase for decades is hidden beneath layers of rules and red tape.
As part of the five-year rule, the beneficiary is compelled to take money out of the IRA over time in the second choice. Unless the IRA is a Roth, in which case taxes were paid before money was put into the account, this can add up to a colossal income tax burden for large IRAs.
Prior to 2020, these inherited IRA options were available to everyone. With the passage of the SECURE Act in late 2019, persons who are not in the first category (spouses and others) will be required to remove the whole balance of their IRA in 10 years and liquidate the account. Annual statutory minimum distributions apply to withdrawals.
When deciding how to take withdrawals, keep in mind the legal obligations while weighing the tax implications of withdrawals against the benefits of letting the money grow over time.
More information on mandatory minimum distributions can be found on the IRS website.
Be aware of year-of-death required distributions
Another challenge for conventional IRA recipients is determining if the benefactor took his or her required minimum distribution (RMD) in the year of death. If the original account owner hasn’t done so, the beneficiary is responsible for ensuring that the minimum is satisfied.
“Let’s imagine your father passes away on January 24 and leaves you his IRA. He probably hadn’t gotten around to distributing his money yet. If the original owner did not take it out, the recipient is responsible for doing so. If you don’t know about it or fail to do it, Choate warns you’ll face a penalty of 50% of the money not dispersed.
Not unexpectedly, if someone dies late in the year, this can be an issue. The deadline for taking the RMD for that year is the last day of the calendar year.
“If your father dies on Christmas Day and hasn’t taken out the distribution, you might not even realize you own the account until it’s too late to take out the distribution for that year,” she explains.
There is no year-of-death compulsory distribution if the deceased was not yet required to take distributions.
Take the tax break coming to you
Depending on the form of IRA, it may be taxable. You won’t have to pay taxes if you inherit a Roth IRA. With a regular IRA, however, any money you remove is taxed as ordinary income.
Inheritors of an IRA will receive an income tax deduction for the estate taxes paid on the account if the estate is subject to the estate tax. The taxable income produced by the deceased (but not collected by him or her) is referred to as “income derived from the estate of a deceased person.”
“It’s taxable income when you receive a payout from an IRA,” Choate explains. “However, because that person’s estate had to pay a federal estate tax, you can deduct the estate taxes paid on the IRA from your income taxes. You may have $1 million in earnings and a $350,000 deduction to offset that.”
“It doesn’t have to be you who paid the taxes; it simply has to be someone,” she explains.
The estate tax will apply to estates valued more than $12.06 million in 2022, up from $11.70 million in 2020.
Don’t ignore beneficiary forms
An estate plan can be ruined by an ambiguous, incomplete, or absent designated beneficiary form.
“When you inquire who their beneficiary is, they believe they already know. The form, however, hasn’t been completed or isn’t on file with the custodian. “This causes a slew of issues,” Tully explains.
If no chosen beneficiary form is completed and the account is transferred to the estate, the beneficiary will be subject to the five-year rule for account disbursements.
The form’s simplicity can be deceiving. Large sums of money can be directed with just a few bits of information.
Improperly drafted trusts can be bad news
A trust can be named as the principal beneficiary of an IRA. It’s also possible that something terrible will happen. A trust can unknowingly limit the alternatives available to beneficiaries if it is set up wrongly.
According to Tully, if the trust’s terms aren’t correctly crafted, certain custodians won’t be able to look through the trust to establish the qualified beneficiaries, triggering the IRA’s expedited distribution restrictions.
According to Choate, the trust should be drafted by a lawyer “who is familiar with the regulations for leaving IRAs to trusts.”
What is exempt from PA inheritance tax?
Property owned jointly by a husband and wife is exempt from inheritance tax, while property inherited from a spouse or a child under the age of 21 by a parent is taxed at 0%. Nine months following a person’s death, inheritance tax returns are due.
Who is responsible for paying inheritance tax in PA?
Probate is the legal process that taxes go through when they pass through a will. Whether or whether there is a will, probate is required to determine who is accountable for estate management, gathering the estate, and disbursing the estate to the heirs. It’s also when will contests and estate lawsuits take place.
Inheritance taxes are a percentage of each heir’s inheritance that must be paid.
These taxes are calculated as a percentage of the total value of each person’s share of the estate.
This means that the recipient of any share of the estate is responsible for paying inheritance taxes.
Some assets, referred to as “non-probate assets,” do not pass through a will or the Pennsylvania intestacy statute.
These assets are normally exempt from the same taxes as other assets.
However, you may be required to pay income tax on any money you receive, and you should consult an attorney about these payments.
In most circumstances, heirs who acquire a portion of someone’s estate are automatically liable to pay inheritance taxes.
Different people are responsible for different amounts of inheritance tax, with those who are more closely connected to the decedent paying less.
For different persons, this is broken down into the following tax percentages:
- The inheritance tax rate for other direct descendants is 4.5 percent. This includes adult children and any direct descendants of those children (e.g., grandchildren, great-grandchildren, )
- Inheritance tax is paid by lineal heirs at a rate of 4.5 percent. This includes your parents, grandparents, and anyone else who is related to you directly.
Adopted children and stepchildren are included in the definition of “children” under these statutes. This means that if your spouse’s children are over 21, they will pay the same 4.5 percent tax as you, or no tax if they are under 21.
Other transfers are exempt from taxation.
Transferring farms to certain qualified parties is subject to a few exceptions.
Bequests to the government, as well as transfers or charitable gifts to specific organizations, are tax-free.
It can be tough to figure out what taxes you owe if you have a complicated or atypical family structure.
Consult an attorney to guarantee that your tax payments are made on time and that you do not incur any late payment penalties.
How much tax do you pay on an inherited IRA?
If you are the beneficiary of a stretch IRA, you must take your first required minimum distribution by December 31 of the year after the death of the IRA owner. To determine the needed minimum distribution amount, you’ll need the following information:
- Your age on December 31st of the year following the death of the original IRA owner; and
What happens when you inherit an IRA from a parent?
Many people believe that they can roll over an inherited IRA into their own. You cannot roll an IRA into your own IRA or treat it as your own if you inherit one from a parent, aunt, uncle, sibling, or acquaintance. Instead, you’ll have to put your share of the assets into a new IRA that’s been established up and properly labeled as an inherited IRA for example, (name of dead owner) for the benefit of (name of deceased owner) (your name).
If your mother’s IRA account has more than one beneficiary, money can be divided into separate accounts for each. When you split an account, each beneficiary can treat their inherited half as if they were the only one.
An inherited IRA can be set up with almost any bank or brokerage firm. The simplest choice, though, is to open your inherited IRA with the same business that handled your mother’s account.
Most (but not all) IRA beneficiaries must drain an inherited IRA within 10 years of the account owner’s death, thanks to the Secure Act, which was signed into law in December 2019. If the owner died after December 31, 2019, this rule applies to inherited IRAs.
What is the difference between an inherited IRA and a beneficiary IRA?
An inherited IRA is one that you leave to someone after you pass away. The account must then be taken over by the beneficiary. The spouse of the deceased person is usually the beneficiary of an IRA, but this isn’t always the case. Although the inherited IRA laws for spouses and non-spouses are different, you can set up your IRA to go to a kid, parent, or other loved one. You can even direct your IRA to an estate, trust, or a beloved charity.
You have three options with your inherited IRA if you’re the surviving spouse. Rather than making it your own, you can simply identify yourself as the account owner, roll it over into another sort of retirement plan, or treat yourself as the beneficiary. You don’t have the choice to make the IRA your own if you’re a non-spouse inheriting the IRA. Either make a trustee-to-trustee transfer or withdraw the account. You’ll almost certainly have to withdraw the funds within five years of the original account owner’s death.
What assets are included in PA inheritance tax?
Is there an inheritance tax on certain types of property? All real and tangible personal property owned by a resident deceased in Pennsylvania at the time of death, including but not limited to cash, automobiles, furniture, antiques, jewelry, and other valuables, is taxed.
How much can you inherit without paying taxes in 2021?
- Because of the extent of the inheritance tax exemption, only a small percentage of estates (less than 1%) are affected.
- The existing exemption, which was doubled as a result of the Tax Cuts and Jobs Act, will expire in 2026.
- The estate tax exemption has been recommended by the Biden administration as being significantly reduced.
What is the 7 year rule in inheritance tax?
Unless the donation is part of a trust, no tax is required on any gifts you donate if you live for 7 years after giving them. The 7-year rule is what it’s called.
If you die within 7 years of making a gift and owe Inheritance Tax, the amount of tax you owe is determined by the date you made the gift.
Gifts made three to seven years before your death are subject to a sliding scale of taxation known as ‘taper relief.’
How do I report an inherited IRA on my tax return?
When an individual taxpayer inherits a traditional IRA from someone other than their spouse, the inherited IRA cannot be treated in the same way as an IRA that the taxpayer owns. Furthermore, if the deceased owner died on or after the date that the deceased owner was obligated to accept minimum distributions from the IRA, the IRA is subject to certain limitations on payments. If the deceased owner had not yet begun to take required distributions, the designated beneficiary may be required to take a distribution from the inherited IRA by December 31 of the fifth year following the deceased owner’s death (or, in some cases, the designated beneficiary must begin a distribution plan based on the beneficiary’s life expectancy within that five-year period). Publication 590-B – Distributions from Individual Retirement Arrangements is a good place to start (IRAs).
When a taxpayer receives a payout from an inherited IRA, they should receive a 1099-R with a Distribution Code of ‘4’ in Box 7 from the financial institution. Unless the dead owner made non-deductible contributions to the IRA, this gross distribution is normally completely taxable to the beneficiary/taxpayer. However, regardless of the beneficiary’s or the deceased owner’s age, a distribution from an IRA to a beneficiary made owing to the death of the original owner is not subject to the 10% early withdrawal penalty.
To enter a distribution from an IRA that was made as a result of a plan participant’s death into TaxSlayer Pro and is reported on a Form 1099-R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, and Other Financial Instruments with Code ‘4’ in Box 7, go to the Main Menu of the Tax Return (Form 1040) and select:
- Select New and specify whether the 1099-R Payee is the Taxpayer or the Spouse.
- In most cases, the taxable amount in Box 2a should be the same as the amount in Box 1. Because the Distribution Code in Box 7 is a ‘4’, there is no need to do anything else after quitting this menu. The 10% Additional Tax for Early Withdrawal does not apply when the Distribution Code is a ‘4,’ regardless of the age of the chosen beneficiary.
NOTE: This is a tutorial for entering a distribution code of ‘4’ on Form 1099-R into the TaxSlayer Pro application. This isn’t meant to be taken as tax advice.
What are the six states that impose an inheritance tax?
Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania are the only states in the United States to collect an inheritance tax as of 2020.